If you owe the bank £100, that's your problem. If you owe the bank £100 million, that's the banks problem.

Cyprus’s Choice: A Failing EU Or Corrupt Kremlin?

The pillars of Cyprus’s economy could be crumbling.

A small country that sometimes slips under the radar is now facing serious problems. Cyprus’s economy is intertwined with that of Greece and the country is now in need of a bailout. But while the other countries in the eurozone have been acquiring these funds from the EU, Cyprus has been taking from the hand of Russia. Last year Russia issued a €2.5 billion emergency loan to help out the country and is now rumoured to provide another loan of €5 billion. This would account for a quarter of Cyprus’s GDP and will help save its troubled banks, which are heavily exposed to the messy Greek banking system. It has been estimated that if Greece were to exit from the euro, the Cypriot banks would require a capital increase of around €9 billion or in other terms 50% of their GDP. In total the Cypriot banks owe around €152 billion, roughly eight times the country’s GDP, and this will need to be brought down over time.

Cyprus is in a tough situation as it can no longer borrow freely from the markets after it was given “junk” credit status, with long term government bond yields currently at 7%. This means the island now relies on loans from either the EU or Russia, but which is the better option?

Most would probably argue the EU is the safer option, and makes more sense as Cyprus is part of the eurozone. But the government is wary of the tight austerity measures the EU have placed on the other members that have asked for bailouts, something a Russian loan does not include. The country would almost certainly be forced to lose its low corporation tax, currently at 10% (compared to the UK’s at 24%) which has helped Cyprus become a tax haven for companies. So the country could turn to Russia again, with the Russians having a vested interest in the safety of the Cypriot economy. A lot of Russian money is currently in the tax haven that is Cyprus, while newly found natural gas resources have been found off the south coast, an appealing thought for Russian companies. But this only masks the real problems; Cyprus cannot avoid the economic reforms that the EU proposes forever. Taking a Russian loan just prolongs the process of returning to the markets, it’s not like Russia will provide loans every year for Cyprus to run its country.

2010 levels of Corporation tax in the EU. Cyprus possess one of the lowest tax levels.

The country has other problems to deal with as well. The economy is expected to decline by around 1% this year after slow growth of just 0.5% last year. The slow growth was partly explained by the Evangelos Florakis naval base explosion, which was reported to have cost the country up to €3 billion (17% of GDP). Unemployment in the country remains high at around 10% and youth unemployment even higher at near 30% of the population, a worrying statistic for a country so small. On top of this the Cypriot government had to cut their budget by €120 million to get its deficit under its intended target of 2.5% of GDP, which have seen cuts in public worker salaries and an increase in the VAT. This is to help tackle the huge debt the country possesses, currently over 70% of GDP. This isn’t to mention the divide that runs through the island, separating Greek-Cypriots and Turkish-Cypriots, which disrupts the country’s economy. Talks have been ongoing but a lack of compromise from Turkey means tensions are as high as ever.

The no-mans land separating Northern and Southern Cyprus.

Things aren’t all gloomy for the country however. They remain part of the EU, which still largely benefits them more than it hinders them. Without such protection, their currency could have proved very volatile to changes in the market, while the EU will continue to offer help to the county accepted or not. The fears of the country’s economy imploding are also not as dangerous as some would think, the costs sound high, but with a bailout fund of nearly €500 billion, the EU could afford to rescue such a small economy. The real danger is that whatever causes Cyprus’s economy to fail (e.g. Greek exit) might cause a country like Spain or Italy to fall, which would crash the whole European market. In these circumstances Cyprus could be forgotten in all the uproar and its people left in a country with no working economy. Such a nightmare scenario remains rare, with the hopes that Angela Merkel and the other European leaders will finally agree on a path out of these worrying times.

Can the major leaders of Europe agree a solution?

For Cyprus, the big question right now is whether they should borrow from Russia or the EU. One promises short-term relief while the other would help concentrate the government on fixing the economy. Let’s hope the Cyprian government makes the right choice, but something tells me the Russian money will win out for now.

Kane Prior

My name is Kane Prior and I like to write about economic issues from around the World. I am a graduate from the University of Kent with a 2.1 degree in Business and Economics. I hope to use this blog to gain interest in myself and maybe lead to some potential career someday. If you want to contact me I am on Twitter (just click on the image) and if you have any writing opportunities for me, then please feel free to drop a message.

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